What Happened to the Asian Miracle?

The Asian Tigers Throughout the 1990s, Asian economies were reporting stellar rates of economic growth Throughout the 1990s, Asian economies were reporting stellar rates of economic growth Per Capita income has increased by a factor of ten over the past 30 years. Per Capita income has increased by a factor of ten over the past 30 years. Asian countries attracted over half of all capital inflows to developing countries Asian countries attracted over half of all capital inflows to developing countries

The Asian Tigers: GDP Growth Country Korea Indonesia Malaysia Philippines Singapore Thailand

The Asian Tigers Throughout the 1990s, Asian economies were reporting stellar rates of economic growth Throughout the 1990s, Asian economies were reporting stellar rates of economic growth Suddenly, however, in the summer of 1997, Thailand devalued the Baht followed by devaluations of the Philippine Peso, the the Malaysian Ringgit, then the Indonesian Rupiah Suddenly, however, in the summer of 1997, Thailand devalued the Baht followed by devaluations of the Philippine Peso, the the Malaysian Ringgit, then the Indonesian Rupiah

The Asian Tigers

Throughout the 1990s, Asian economies were reporting stellar rates of economic growth Throughout the 1990s, Asian economies were reporting stellar rates of economic growth Suddenly, however, in the summer of 1999, Thailand devalued the Baht; followed by devaluations of the Philippine peso, the the Malaysian Ringgit, then the Indonesian Rupiah Suddenly, however, in the summer of 1999, Thailand devalued the Baht; followed by devaluations of the Philippine peso, the the Malaysian Ringgit, then the Indonesian Rupiah Following the devaluation, the region suffered a major contraction and persistently lower rates of economic growth. Following the devaluation, the region suffered a major contraction and persistently lower rates of economic growth.

The Asian Tigers: Post Crisis GDP Growth Country Korea Indonesia Malaysia Philippines3435 Singapore69-22 Thailand

Why did Asia Collapse Malaysian Prime Minister Mahathir Mohamad has been the wild man of the Asian crisis, blaming all his problems on manipulations by Jewish speculators Malaysian Prime Minister Mahathir Mohamad has been the wild man of the Asian crisis, blaming all his problems on manipulations by Jewish speculators Was the Asian Crisis due to irrational speculation or were there real structural problems in Asia? Was the Asian Crisis due to irrational speculation or were there real structural problems in Asia?

The Good News On the surface, the Asian economies looked very strong On the surface, the Asian economies looked very strong High rates of economic growth High rates of economic growth High labor productivity growth High labor productivity growth High rates if investment financed by high domestic savings High rates if investment financed by high domestic savings Low government deficits Low government deficits

Investment Rates (% of GDP) Country Korea Indonesia Malaysia Philippines Singapore Thailand Taiwan

Savings Rates (% of GDP) Country Korea Indonesia Malaysia Philippines Singapore Thailand Taiwan

Labor Productivity Growth Country Thailand

Government Deficits/Surplus (% of GDP) Country Korea Indonesia Malaysia Philippines Singapore Thailand Taiwan

More Good News Asian Stock and Real Estate Markets were booming Asian Stock and Real Estate Markets were booming

Stock Market Indices Country Korea Indonesia Malaysia Philippines Singapore Thailand Taiwan

However, underneath the good news…… Was Asian growth due to “inspiration” or “perspiration”? Was Asian growth due to “inspiration” or “perspiration”?

However, underneath the good news…… Was Asian growth due to “inspiration” or “perspiration”? Was Asian growth due to “inspiration” or “perspiration”? All the Asian countries had very high rated f labor productivity growth, where labor productivity is defined as All the Asian countries had very high rated f labor productivity growth, where labor productivity is defined as LP = Y/L (real output per labor hour) This measure of productivity omits an important input This measure of productivity omits an important input

Sources of Economic Growth Recall, that we assumed three basic inputs to production Recall, that we assumed three basic inputs to production

Sources of Economic Growth Recall, that we assumed three basic inputs to production Recall, that we assumed three basic inputs to production Capital (K) Capital (K) Labor (L) Labor (L) Technology (A) Technology (A)

Sources of Economic Growth Recall, that we assumed three basic inputs to production Recall, that we assumed three basic inputs to production Capital (K) Capital (K) Labor (L) Labor (L) Technology (A) Technology (A) Growth accounting attempts to separate the growth effects of each input Growth accounting attempts to separate the growth effects of each input

Growth Accounting Step 1: Estimate capital/labor share of income K = 30% L = 70%

Growth Accounting Step 1: Estimate capital/labor share of income K = 30% L = 70% Step 2: Estimate capital, labor, and output growth %Y = 5 %K = 3 %L = 1

Growth Accounting Step 1: Estimate capital/labor share of income K = 30% L = 70% Step 2: Estimate capital, labor, and output growth %Y = 5 %K = 3 %L = 1 Productivity growth will be the residual output growth after correcting for inputs

Growth Accounting Step 1: Estimate capital/labor share of income K = 30% L = 70% Step 2: Estimate capital, labor, and output growth %Y = 5% %K = 3% %L = 1% Productivity growth will be the residual output growth after correcting for inputs %A = %Y – (.3)*(%K) – (.7)*(%L)

Growth Accounting Step 1: Estimate capital/labor share of income K = 30% L = 70% Step 2: Estimate capital, labor, and output growth %Y = 5 %K = 3 %L = 1 Productivity growth will be the residual output growth after correcting for inputs %A = %Y – (.3)*(%K) – (.7)*(%L) %A = 5 – (.3)*(3) + (.7)*(1) = 3.4%

Sources of US Growth Output Capital Labor Total Input Productivity

Productivity Growth in Thailand Labor productivity growth in Thailand averaged around 15% in the 90’s, but how much of this was technological? Labor productivity growth in Thailand averaged around 15% in the 90’s, but how much of this was technological? %Y = 8 %Y = 8 %L = 3 %L = 3 %K = 40 %K = 40

Productivity Growth in Thailand Labor productivity growth in Thailand averaged around 15% in the 90’s, but how much of this was technological? Labor productivity growth in Thailand averaged around 15% in the 90’s, but how much of this was technological? %Y = 8 %Y = 8 %L = 3 %L = 3 %K = 40 %K = 40 %A = 8 – (.7)(3) – (.3)(40) = -6

The Bad News The growth in Thailand was attracting lots of foreign investment and was fueling an investment boom. The growth in Thailand was attracting lots of foreign investment and was fueling an investment boom. This boom was largely debt financed This boom was largely debt financed However, without technological improvement, this growth is not sustainable. However, without technological improvement, this growth is not sustainable.

Bank Lending (% of GDP) Country Korea Indonesia Malaysia Philippines Singapore Thailand Taiwan

Finances of Korean Chaebol (in 100 Million Won) ChaebolDebtDebt/EquityRatioSales Jinro Sammi Halla New Core Bongil Hanhwa

Asian Financing While these countries did have high domestic savings rates, much of the financing came from overseas While these countries did have high domestic savings rates, much of the financing came from overseas

Current Account Balance (% of GDP) Country Korea Indonesia Malaysia Philippines Singapore Thailand Taiwan

Foreign Debt (% of GDP) Country Korea Indonesia Malaysia Philippines Singapore Thailand Taiwan

Asian Financing While these countries did have high domestic savings rates, much of the financing came from overseas While these countries did have high domestic savings rates, much of the financing came from overseas Further, a large fraction of this debt (20-70%) was short term. Further, a large fraction of this debt (20-70%) was short term.

Asian Financing: Moral Hazard A further complication was that the Asian governments implicitly backed all private sector loans. This exacerbates the natural moral hazard problem already present in financial markets A further complication was that the Asian governments implicitly backed all private sector loans. This exacerbates the natural moral hazard problem already present in financial markets

The Beginning of the End By the mid nineties, the profitability of Asian companies began to fall By the mid nineties, the profitability of Asian companies began to fall

Return on Assets by Korean Chaebol Chaebol Hanbo3%1.7% Sammi2.9%3.2% Jinro2.7%1.9% Kia18.9%8.7% Dainong6.8%5.5%

The Beginning of the End By the mid nineties, the profitability of Asian companies began to fall By the mid nineties, the profitability of Asian companies began to fall As profits fell, loan defaults increased As profits fell, loan defaults increased

Non-Performing Loans (% of Total Loans) Country1996 Korea8 Indonesia13 Malaysia10 Philippines14 Singapore4 Thailand13 Taiwan3

To Make Matters Worse Most countries were pegged to the dollar. As domestic inflation rates rose, they experienced a real appreciation against the US. Most countries were pegged to the dollar. As domestic inflation rates rose, they experienced a real appreciation against the US.

To Make Matters Worse Most countries were pegged to the dollar. As domestic inflation rates rose, they experienced a real appreciation against the US. Most countries were pegged to the dollar. As domestic inflation rates rose, they experienced a real appreciation against the US. As the dollar appreciated against the Yen, so did the Baht, Ringgit, etc. As the dollar appreciated against the Yen, so did the Baht, Ringgit, etc.

To Make Matters Worse Most countries were pegged to the dollar. As domestic inflation rates rose, they experienced a real appreciation against the US. Most countries were pegged to the dollar. As domestic inflation rates rose, they experienced a real appreciation against the US. As the dollar appreciated against the Yen, so did the Baht, Ringgit, etc. As the dollar appreciated against the Yen, so did the Baht, Ringgit, etc. Japan slid into a recession in the early nineties. Japan slid into a recession in the early nineties.

Liquidity Problems With exports falling, there was insufficient cash to refinance short term borrowing With exports falling, there was insufficient cash to refinance short term borrowing Further, many of these loans were dollar denominated, which put additional strain on dollar reserves (to maintain the peg) Further, many of these loans were dollar denominated, which put additional strain on dollar reserves (to maintain the peg)

Why not float?

With many loans denominated in dollars, a currency depreciation raises the value of the loan in domestic currency. With many loans denominated in dollars, a currency depreciation raises the value of the loan in domestic currency. Domestic interest rates would have to be raised to attract capital (interest rates would need to compensate for the currency depreciation) Domestic interest rates would have to be raised to attract capital (interest rates would need to compensate for the currency depreciation)

Is maintaining the peg better?

Not really…….by maintaining the peg to the dollar, the central bank must continue to buy up domestic currency which contracts the domestic money supply. Not really…….by maintaining the peg to the dollar, the central bank must continue to buy up domestic currency which contracts the domestic money supply.

Enter the IMF As the Asian debts piled up, the IMF (International Monetary Fund) intervened. The offered emergency loans, but with strings attached. As the Asian debts piled up, the IMF (International Monetary Fund) intervened. The offered emergency loans, but with strings attached.

Enter the IMF As the Asian debts piled up, the IMF (International Monetary Fund) intervened. The offered emergency loans, but with strings attached. As the Asian debts piled up, the IMF (International Monetary Fund) intervened. The offered emergency loans, but with strings attached.

Enter the IMF While the IMF did not insist that the countries maintain their pegs at all cost, they required three policies to “restore confidence” While the IMF did not insist that the countries maintain their pegs at all cost, they required three policies to “restore confidence” Raise interest rates Raise interest rates Balance Government Budgets Balance Government Budgets Conduct Fundamental Reform Conduct Fundamental Reform

Did the IMF make things better, or worse? Those countries that were able to meet the requirements slipped further into recessions Those countries that were able to meet the requirements slipped further into recessions Those countries that couldn’t meet the requirements suffered further “investor confidence” Those countries that couldn’t meet the requirements suffered further “investor confidence”

Malaysia opts out Malaysia, rather than accepting the IMF terms, chose to follow a different strategy Malaysia, rather than accepting the IMF terms, chose to follow a different strategy Malaysia imposed capital controls which restricted capital flows out of the country. Malaysia imposed capital controls which restricted capital flows out of the country. This allowed Malaysia the freedom to follow more expansionary policies without worrying about losing foreign capital. This allowed Malaysia the freedom to follow more expansionary policies without worrying about losing foreign capital. This strategy seemed to work in that Malaysia recovered faster than other countries. This strategy seemed to work in that Malaysia recovered faster than other countries.

What’s the moral of the story In bad times, policies required to maintain external balance (currency value) turn out to be policies that would never have been considered in countries with a peg. In bad times, policies required to maintain external balance (currency value) turn out to be policies that would never have been considered in countries with a peg. Typically, the better solution is: Typically, the better solution is: Devalue, but devalue “enough” Devalue, but devalue “enough” Drop the peg and concentrate on economic recovery. Drop the peg and concentrate on economic recovery.